Economics & Investing: Risks of a 2008 style crisis are rising

With the European economies weakening fast, left and centre, its capital markets suffering from wave after wave of panic selling, any one of the following threats could set off a 2008-style crisis.

Triple “A” European economies weakening

Supposedly “strong” Triple “A” European countries such as Germany and France have so far pledged tens of billions of Euros in aid to their weaker Euro partners Portugal, Ireland, Greece and Spain. However, they could be called on to spend even more to support Belgium, Cyprus, and the potential biggest crises candidate of all – so far, at least – Italy. But there is a bit of a problem. As I mentioned earlier last week, these once-strong economies are now also sinking fast. In fact, German GDP grew just 0.1 per cent in the second quarter, much worse that its 0.8 per cent growth in the first quarter. France's economy did even worse, flat-lining in the most recent quarter. In the last few days, a possible downgrade in France's AAA ratings, as well as several of its largest banks, due to their immense Greek bond holdings, has spooked the markets. If this were to happen, France may well need to decide to back out from any additional massive bailouts of some of the other even weaker European countries if and when required. Both France and Italy may well decide to sell off part of ther gold holdings, as well as embark on additonal rounds of austerity cut backs. Whether President Sarkozy's target of approximately $17bn in budget cuts to get his country’s deficit under control will be enough if and when it loses its Triple A rating is doubtful.

Greek bailout plan under threat

Greece managed to secure a Euro 109 bn bail-out program out of its European neighbours in July. But, the implementation of this plan is still in serious jeopardy with Finland wanting Greek national assets as collateral for its contribution to the bail-out package. Meanwhile, the bail-out is also contingent on 90 per cent of Greek bond investors agreeing to a debt swap to lower the country’s financing costs. Many creditors are baulking to sign up to this. However, if not more creditors agree to this haircut, it could sabotage the entire Greek bail-out. With potential dire consequences for other bail-out programs for Portugal and Ireland.

Moody's - the rating agency - has announced today that it has downgraded the long term debt ratings of Credit Agricole and Societe General - France's second and third largest banks by assets. BNP - France's largest bank has its long-term rating is been kept on review for a possible cut.

French lenders top the list of Greek creditors with $56.7 billion in exposure to private and public debt, according to a June report by the Basel, Switzerland-based Bank for International Settlements.

Interesting to see Terry Smith on Newsnight (from about 9 minutes in) last night warning that if Germany bailed out Greece (and was thereafter forced into bailing out the other perpherals) then it could "bankrupt" itself. The obvious way forward is not going to be another bailout - but instead a Greek default, with a big haircut for all those holding Greek risk (hence the French bank downgrade, I guess).

Smith expects Greece to leave the euro and to default. He made a good analogy about a wayward child being allowed out with the parents' Platinum credit card.

The default scenario seems to be an increasingly widely-held view ....but not necessarily a bad thing in terms of market confidence.

"Standard & Poor's cut Italy's credit rating by one notch to A, from A+, with a negative outlook. The move is the rating agency's first downgrade of the Eurozone's third-largest economy since 2006.﻿ As for the reasons behind yesterday’s decision, S&P noted Italy’s “weakening economic prospects” and the difficulty of the “fragile governing coalition” being able to respond decisively to the debt crisis."

"Moody’s also stated it would continue to review Italy’s finances, although ultimately we expect them to follow S&P’s lead and assign a lower credit rating to the country."

"Though we remain very cautious across the fixed income markets of Europe’s southern periphery, especially Greece, Portugal and Ireland, we view the fundamental story for Italy as a little more constructive."

"Compared to these peripheral countries, Italy’s fiscal position is more favourable, with relatively low levels of private indebtedness, and if the government successfully follows through on its plans for fiscal reform including, in full, the €60bn austerity programme which has recently been agreed by parliament, then this could go some way to achieving a balanced budget by 2013."

"However, the task ahead for the Italian Government ought not to be underestimated. Current plans require measures of institutional reform, revenue expansion and cost cutting to an extent never before executed within this economy – there are sure to be both successes and failures along the way and the prospect remains for a period of heightened volatility across all Italian risk assets."

"We do take some comfort from the European Central Bank continuing its buying programme of Italian (and Spanish) bonds though believe this is only a temporary measure ahead of the full ratification of the enlarged powers of the European Financial Stability Facility possibly in mid-October."

Not a major issue at all. The number of AAA countries has always been quite tiny.

The ONLY thing that is important from a rating perspective is whether there are more countries in danger of losing their "Investment Grade" status....which there are.....but even the latest cut of Italy to A still leaves them four notches inside the Investment Grade category!

I'd also note that I am old enough to remember being surprised when Italy was upgraded to AA2. In my mind it has always been an A/A+ type credit!

I suppose the more pertinent question is will those countries losing their triple A rating have to pay more to borrow - the case of the US would seem to indicate a resounding "No". Admittedly other triple A rated countries don't have the luxury of the Reserve currency, and the tendency of everyone, when panic strikes, to seek the dollar and UST as a safe haven...but I'd wager a one notch downgrade of the UK would have similarly little impact on gilt yields.

But it's certainly looking rather ominous out there as the slow train wreck that is the Eurozone winds its way to the inevitable point of implosion.

What people often overlook is that credit ratings are supposed to be an ABSOLUTE measure.....so that they are consistent through time.

If every country in the world got downgraded by four notches, then the chances are that the borrowing costs of countries that are A+/A1 would actually be lower than when they had been rated AAA....because in RELATIVE terms they have become much safer places to lend to than the other countries who have been downgraded beyond the (Investment Grade) pale!

In addition of course the USD remains the global reserve currency - and those countries that have flirted with moves to add Euro reserves are likely to switch back to the USD!

Interesting to see that gold prices have started falling with everything else though........suggests to me that the "fear trade" is perceived to be nearer the end than the beginning (even though it could get even uglier in coming weeks).

Yes it has been interesting to see Gold fall recently - is this the start of the correction, or perhaps just some profit taking before the next upward move. The rise has certainly been meteoric. The dollars recent strength hasn't helped either.

My own views are that we will see more volatility in gold, with $100 a day moves becoming the norm and a return to an upward trend as the Eurozone implodes. There is simply no way Greece can remain in the Euro, or for that matter Portugal,Ireland, Italy - the economics of their membership just don't stack up. A core Eurozone has a chance, the current one is far too inflexible for most members. The panic that a default( current actions to date have merely delayed this,kicking the problem down the road) will result in should see Gold surge alot higher imv. Once the Eurozone implodes, market focus will move to the US and it is only then that the dollar will lose it's safe haven status as the USA collapses under the weight of its extraordinarily high debt.

How to preserve wealth in these difficult times? If you're right, and gold continues to go down with everything else where is capital best protected in your view?

Well here we are at 5 mins (OK 10 mins) to midnight and after endless meetings over the past 3 months it turns out we're no further forward as regards the Teutonic nein and the Gallic allez.

http://www.cnbc.com/id/44963510Plans to tackle the euro zone debt crisis have stalled with Paris and Berlin at odds over how to increase the firepower of the region's bailout fund, French President NicolasSarkozy said on Wednesday.

We are of course going to get a fudge next week which nobody will believe least of all the markets

And for stockpickers its doubly frustrating isnt it as this on the money FTshort video from last week appositely describes.

Interestingly, some of those Things of Enduring Value in my portfolio, specifically, Encore shares, Polo shares, Carpathian (LON:CPT) shares (or, even more specifically, the underlying assets they represent) seem to keep turning back into larger amounts of cash. :0) So, despite my best efforts to reinvest, my cash level is back at over 15%. Ah well, plenty more firepower to use when bargains present themselves, as they undoubtedly will in these ultra-volatile markets.

Whilst its painful to see your mark-to-market value taking a steep tumble, if you've got your own assessment of value right, it's simply a question of time until something happens to unlock the value. In the years to come, I'm sure we'll be telling tales of the incredible bargain we were able to pick up in these extraordinary times. Hope there won't be too many tales of Things not turning out to be what they seemed tio be.

Looks like it's "man overboard" again tomorrow - and unfortunately I'm out most of the day, so bargain hunting may have to wait until Friday - or next week.

And for stockpickers its doubly frustrating isnt it as this on the money FTshort video from last week appositely describes

Only if you think short-term (i.e. weeks and months) rather than years. That's where us PIs have a big advantage over fund managers who are judged on a short-term basis. We are our own judges, and my own criteria are based on long term performance not on that of a few months or even one year.

Must admit, asset allocation is very useful in such volatile conditions, forcing some selling when prices rise, thus allowing reinvestment at lower prices, when they fall. I find that this helps boost returns and lower average entry prices for stocks.

Indeed people can't stay in cash forever - however I suspect many are taking the opportunity cost that is declining purchasing power due to inflation in the hope that asset values (stocks,property) take a significant bath in the near time thereby gaining in the long term. I'm certainly doing this myself - and, unfortunately have been doing so for a while now as the Eurozone implosion has been inevitable imv since 2007.

It's been a painful long term play so far and , like others, I have dripped in some funds on the large dips to mitigate that somewhat. Property is still too expensive, and markets are not fully pricing in the coming downwave. Most of my investments have been defensive( blue chips/oil, gold, silver) with the odd sprinkling of riskier plays. The juicy yields, assuming they contain, are just too attractive compared to bank deposit rates but, given i'm not in work, capital preservation(as best as one can) has been the main focus, even if its purchasing power is gradually eroded.

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